Comparative advantage

In economics, the theory of comparative advantage explains why it can be beneficial for two countries to trade, even though one of them may be able to produce every kind of item more cheaply than the other.

Related Topics:
Economics - Trade

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What matters is not the absolute cost of production, but rather the ratio between how easily the two countries can produce different kinds of things. It was first described by Robert Torrens in 1815 in an essay on the corn trade. He concluded that it was to England's advantage to trade various goods with Poland in return for corn, even though it might be possible to produce that corn more cheaply in England than Poland. However, it is usually attributed to David Ricardo who explained it clearly in his 1817 book The Principles of Political Economy and Taxation in an example involving England and Portugal. In Portugal it is possible to produce both wine and cloth with less work than it takes in England. However, the relative costs of producing those two goods are different in the two countries. In England it is very hard to produce wine, and only moderately difficult to produce cloth. In Portugal both are easy to produce. Therefore, while it is cheaper to produce cloth in Portugal than England, it is cheaper still for Portugal to produce excess wine, and trade that for English cloth. And conversely England benefits from this trade because its cost for producing cloth has not changed but it can now get wine at closer to the cost of cloth.

Related Topics:
Robert Torrens - 1815 - David Ricardo - 1817

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When one entity (be it a firm or a country) is able to produce more efficiently than another entity it has an absolute advantage; that is, assuming equal inputs, the entity with an absolute advantage will have a greater output.

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Stanislaw Ulam once challenged Nobel laureate Paul Samuelson to name one theory in all of the social sciences which is both true and nontrivial. Several years later, Samuelson responded with David Ricardo's theory of comparative advantage.

Related Topics:
Stanislaw Ulam - Nobel laureate - Paul Samuelson - David Ricardo

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:"That it is logically true need not be argued before a mathematician; that it is not trivial is attested by the thousands of important and intelligent men who have never been able to grasp the doctrine for themselves or to believe it after it was explained to them."—Paul Samuelson

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Ricardo's principle relies on a variety of assumptions that are arguably false, such as there is no cost of transportation, no externalities such as environmental contamination or social inequities.

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Because the theory produces a counter-intuitive result, it may be useful to consider the following:

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